Mortgages: 15 Year Fixed vs. 30 Year Fixed + Prepayment?

I should preface this with the fact that I’m still very new to mortgage loans in general. I’ve been considering getting a 15-year loan instead of a 30-year fixed loan. The general consensus seems like if you can afford a 15-year fixed mortgage, you should go for it. The interest rate will be lower, you own your home in half the time, and the payments aren’t actually that much higher (definitely not double). But what if you just took a 30-year fixed mortgage and had the discipline to pay enough extra each month to equal the 15-year payment? Would you really be that far behind? The results surprised me.

Using the current average mortgage rates at Bankrate.com (5.68% for 15-year fixed, 5.96% for 30-year fixed):

15-Year Fixed
$300,000 loan at 5.68%, the monthly payment would be $2,480.

30-Year Fixed
$300,000 loan at 5.96%, the monthly payment would be $1,790.

So the difference is $690 (a 38% increase over $1,790). Now, what if you took the 30-year mortgage with no prepayment penalty, and still paid $2,480 each month? According to the calculator at Dinkytown.net, I would shave off 14 years and 6 months. So, it turned my 30-year mortgage into a 15.5-year mortgage!

Since I’d be paying $2,480/month for an extra six months, that would give me an extra cost of about $15,000. That’s a good chunk of money, but I still saved tons of interest over the 30-year loan and in exchange I got the flexibility of making smaller payments if needed. Could be job loss, unexpected expenses, real estate investment opportunity, whatever.

Am I missing something? The interest paid should be about the same, so I’m not losing out on any deductions between the two. Of course, I would need the discipline to keep up the extra monthly payments since the bank won’t be hounding me for it. But if that’s the only obstacle, I would probably prefer the 30-year fixed vs. the 15-year loan.

Comments

  1. Yes, the math is about right — $70/month is a good price to pay for the flexibility., There are two more things to consider:

    1) Of course the extra $15,000 is interest expense, so depending on your tax situation, you might get a tax benefit of $200-$300/year.

    2) How long do you want to stay in the house? Given that we are almost at the peak of this tightening cycle, adjustable rate mortgage may be an even better option now.

    Just my 0.02.

  2. Hi! With reference to the30 year mortgage and the 15 year mortgage.
    I can only give a little bit of advice, having done exactly what you are thinking of doing.
    There is one catch however, and a very important one.
    You must be absolutly sure that you have “NO” prepayment penalty clause in your mortgage contract.
    Most contracts do contain this clause, so if you did pay off your 30 year mortgage, in half the time you would be stuck with a rather large penalty.

    In my case we managed to get this clause eliminated officially from the contract, then took out the 30 year mortgage.
    We managed to pay it off in 15 years.

    Not an easy task however, you also must be careful that when you send your payments in monthly, that you do not combine the monthly amount of your mortgage with the additional payment.

    Make sure the addtional payment comes straight off the principle.

    It can be a problem if the bank recieves your two payments and uses the second payment for paying the next months payment, you certainly do not want that to happen.That would be paying your mortgage ahead, but not having it deducted from the principle would not save you a penny.

    The second payment MUST be designated for principle reduction only.

    Safeguard yourself by taking a 30 year mortgage then if trouble arises or an emergeny arises you can pay the actual smaller
    mortgage monthly payment.

    Good Luck you are making a very wise move. Cheers Jim

  3. You are correct, when the spread between 15 and 30 yr mortgage is minimal, then getting the 30 yr mortgage and paying extra principal so that it is equivalent to the 15 yr mortgage is not a bad idea. With many banks, you can set up the automatic withdrawal to include a fixed extra principal to help with the discipline.

  4. We tend to mostly use variable rate mortgages here in Australia, with a standard term of 25 years. Generally you are allowed to pay off extra with a variable rate loan, and can redraw the ‘excess’ payments at any time. This comes in handy in case you are laid off.

    Fixed rate loans are available – but they are mostly used by investors to take out interest only loans when buying rental property.

    Some people take out fixed rate loans (the max fixed period is 5 years here, then they revert to variable or you have to rollover for another 5 years at a new fixed rate).

    Of course things are different in the US, but one thing that will be the same is that the banks set a fixed rate that has a margin built in to cover interest rate risk. So, in most cases you are paying a premium to move this risk from you to the bank. As long as you’re happy taking out this form of insurance, go ahead and take out a fixed rate loan.

  5. This is a slam dunk 30 yr wins! Two factors to consider – 1) The interest rates on the 15 vs. 30 are both low and with only a small difference. If it were a huge spread then the 15 may be more attractive. However, the 30 gives you close to the same rate with the flexibility to paydown or better yet, use your money for a higher yielding investment. 2) This is cheap debt! Look at those rates and consider the tax impact. You are buying an appreciating asset with cheap debt. Don’t tie it all up in a 15yr.

  6. I’ve always thought the same thing, but, like you, I’m new to this mortgage thing. From reading around it seems that it usually isn’t recommended because few people have the discipline to actually follow through. They must not be familiar with the willpower of the pf blogging community. =D

  7. I forgot to mention that there also may be some sort of early payment penalty, you have to check with the lender.

  8. Jonathan –
    Just wanted to let you know that my wife and I were in a similar situation a year ago when we were buying our first house. We looked at my income (she’s a stay-at-home), and figured that we could pay it off in 15 years, but we wanted the flexibility if necessary to pay it off in 30. So, for the time being, we make sure to put in at least whatever the principle payment for that month.
    This way, we will still get the loan down to less than 15 years, our mortgage payment grows over time (as inflation/raises increase), but we have flexibility in case I am without a job, or we have a large unplanned expenditure.

  9. Jonathan, that is exactly how I am handling my mortgage. I got a 30-year loan, but am tacking on more money in each monthly payment so that it’ll be paid off in about 16 years.
    I like the fact that I can vary the amount of the extra payments. I’ve had to adjust it (the extra payment) a couple of times in the last 4 years.

    There is no downside, at least for me. YMMV.

  10. You also should weigh whether or not you can get a better return over these 15 years than the effective after tax deduction APY (probably closer to 5%) of your mortgage investing the money elsewhere than putting it into your mortgage. Plus the extra flexability that would provide having your funds outside your home. A equity loan on your home right now would run you somewhere around 7-8% if you ever need this money.

    I’m not trying to suggest you can definetly or even probably get higher returns elsewhere, just something to think about.

  11. I’d go with the 30-year fixed and prepay. There will probably be some crisis or other where you are going to want to pay your smaller mortgage payment. Rather than getting locked in to the higher amount, you surely can discipline yourself to make the extra principal payments. It’s really not that hard. The problem is the mortgage lender and how they handle the extra money you send. My bank knows automatically to take any extra and apply it to the principal from my electronic payment. When I need to add to my escrow balance, I send in the actual coupon marking down what goes into escrow. Works out well, but I think not all banks do this which is why people do funky ‘bi-weekly’ programs with stupid extra fees.

    The other thing is that there is a 20-yr mortgage product out there. You just have to ask for it. A lot of banks are willing to write different terms if you ask them what is possible. I asked for rates on a 7/1 and 10/1 ARM from my lender because she was initially going to write me a 5/1 I/O. I am MUCH happier with a longer term ARM because it’s P&I and the difference in monthly payment was only about $100.

    The Peter Miller mortgage book I have linked on my site is really good at detailing the different mortgage products out there, and the 15 vs 30 yr fixed mortgage. I highly recommend it. I learned A LOT from it when I was shopping for mortgages. Sadly, I’d offer you my copy, but I already sent it to a friend. (I bought it used too for $4 bucks!) :-)

  12. 30-year mortgage rate is higher than 15-year’s.

    Even if you pay the same on either one, 30-year mortgage would have more interest component and less principle component than 15-year mortgage. In order to pay off principle, you will make more payments on 30-year loan.

    30-year mortgage is definitely more flexible when 15-year mortgage is a stretch.

  13. That’s we did. We took out a 30 year mtg a in 2000. Made extra payments toward principal. Using an amortization table, I charted our progress. When we hit a break even point, we refinanced into a home equity line/loan for 10 years at a lower rate than our 30 yr mtg. We are still making extra payments on our home equity and if we continue at the pace we are going will have paid it off the beginning of 2008.

    But you are right you need the discipline to do this or if you set up ACH to pay your mortgage, designate a sum to extra toward principals.

  14. You’re not missing anything. $15,000 over the course of 15 years is a pretty reasonable price to pay for being able to (basically) switch between a 30 year and 15 year mortgage at will. As you indicated, you could lose your job, or decide to rent the place out, etc.

  15. I thought about that, but I set my sights on a lower loan ($100,000 area) on a 15 year and am paying extra cash on that when possible. That way I’m paying it off in less than 10 years AND paying less interest (5.5% loan in my case). So similar concept, but less interest/loan amount/payoff date.

  16. Don Marek says:

    I am not able to consider owning a home yet, but I always thought it would be better to take the longer term loan and pay more on it.

    If one were to have a financial set back such as a spouse was ill and could not work or one had less income to work with for some reason, one could pay only the minimum until things return to normal.

    That is a good idea though to compare to the 15 year mortgage to a 30 year. I’ll have to remember that when I am able to join the propertied class.

  17. Jon, this is an interesting topic. Because I did not run the caluculator, I can not confirm that one will be able to pay off the 30-year mortgage in 15.5 years. One trick you may want to know is that you need to pay the extra amount as “principal only” (please indicate this in your checks) before your monthly payment is due. This will save you more in the interest because the way amortization is calculated. Another observation is that when people bought a house, they did not have much left. It will be difficulty to find extra fund to pay extra on the mortgage, not to mention how many pieces of new furnitures and appliances to buy. Surely you have some good points as to unexpected events. Property tax, insurance premium and association fee (if any) will go up as time goes by. They all can be part of your monthly payment. Another source of expenses is the home improvement. Frankly, I alway feel that owning a house is like owning a “black-hole” of spending money. If you buy an old house, very like its roof will be replaced within 15 year period. You may need to fix many other things in house as well. Always have some extra fund for emergent repairs! I agree that getting 30-year mortgage will provide you some flexibility.

  18. I think the key is not to apply the $690 “saved” to your mortgage but to an investment yielding more than 5.96%. Have to account for tax effects obviously. You could probably pay off the mortgage in 15 yrs with the investment build up.

  19. Jeremy Newman says:

    The differential in interest accumulation can be attributed to the 28 basis point spread between the 30-yr and 15-yr rate, so therefore you would not pay the same amount of interest in the same 15 year period.

    However, if you are looking for the option of paying down a mortgage with a 15 yr am, but want the flexibility of only paying the IO or 30 am payment, their are several lenders out there that can provide you with an “options payment” that allows the consumer to choose which payment method they want to make.

    Good luck and congratulations on moving toward home ownership. It is a dream that many of us Califorians will have to wait a long time for.

  20. I did something like this while paying my car loan. I had a 60 months loan. Each month I added extra $ amount to my payment. I paid off my car in 42 months. Of course I didn’t get any tax benefit on auto loan interest. I will definitely do the same thing when I buy a house.

  21. the-insider says:

    Jonathan,
    you are not missing anything! It’s called efficient markets – mortgage rates for 15 and 30 year are different because the markets charge a slight premium for loaning you the money for a longer period. Whether $15K is reasonable amount to shell out for life’s uncertainties, it’s an individual decision – My personal experience is that taking a 15 year mortgage brings in a lot of discipline and protects one from the occasional desire to splurge on couple of months worth of extra payments.

  22. I think you should absolutely do the 30 year versus the 15, as long as you do plan on making the same monthly payments as the 15. One benefit is that if you can’t make the increased payment on a certain month, you have the option of making the regular minimum payment on the 30 year. If you do the 15, you don’t get that option. Not that you should abuse that option, as you’ve pointed out – it takes discipline to pay more than you are required to every month. I took a slightly different and less aggressive approach with my mortgage – its a 30 year variable, but I add 1/12th of my monthly payment to each payment, so that I end up making 13 payments a year. I crunched the numbers once, and it shortened the mortgage life by 5 years and saves $23,000 in interest. You’ll make a great decision by taking the 30-yr fixed.

  23. blogoversary says:

    The key is having the discipline because paying less just a few times can balloon the cost – if you keep on track and pay the same anmount it will cost more over the long run, but it will give you more flexibility if there is an emergency.

  24. Joe Banks says:

    Those rates at Bankrate.com are just loss leaders to get you to patronize their advertisers. You can add about a half a point to the low rates posted on the first page to see what you can get with excellent credit and no debt.

  25. Jonathan,

    You have a knack for reading my mind and writing on topics that I was just pondering myself! We got our first mortgage (30-year fixed) in February. Went with the “preferred lender” for our builder because of the $10,000 cash incentive they were offering, but we didn’t get the rate we wanted. We just refinanced last month and went with a 15-year fixed. After the fact, (and after we had paid our $500 to lock in the rate with this new lender), I began to think what if we just started paying more on our 30-year mortgage each month? Our payment is only $250 more each month with the 15-year fixed, so I’m sure we could swing that on our own, without it being the required payment. I’m kind of afraid to do the math, because I don’t want to find out that we made a bad decision. However, we did get the rate lowered by .75%, so I’m thinking that we will probably come out ahead, even if just by a little.

    Great topic though. I was one of those people that assumed going from a 30-year fixed to a 15-year fixed would double my payment, which is not the case at all. Definitely something for everyone to at least look into.

  26. I just ran the numbers with 6.0%/6.5% and 6.5%/7.0% rates for 15/30 year, and with the 30 year + prepayment you’d shorten the length to 14.25 years.

    With 6.75%/7.0%, it would be shortened to 14.6 years.

    So depending on the rate spread, you can actually do better than a 15 year by doing 30 year + prepay!

  27. Just ran the calculator at Dinkytown.net. Turns out that if I had kept the 30-year fixed and increased my payment to what it now is with the 15-year fixed, I would shave 12 years and 9 months off my mortgage term, with a total savings of $90,587. By switching to the 15-year fixed, I will save approximately $106,000. Yes, I lose the flexibility of making a lower payment if we have to, but in our case, we have plenty saved up to ensure we can always make this higher payment. In fact, we are even increasing our new 15-year payments a little in the hopes of paying the mortgage off even earlier.

    So, even though the consensus here seems to be that the 30-year fixed is much better, I think it really depends on the individual situation. Namely, the difference between the rates, and if you can handle the commitment of the larger payment.

  28. For all of you that say putting the extra you save w/ a 30yr into an investment that does better than the ~6%, I would just like to bring up the old adage that the borrower truely is slave to the lender. The day you pay off your mortgage, you will come home, and your grass will be greener, your carpet will be softer, your bed will be fluffier, and your tap water might even be good enough to drink! Just something to keep in mind.

  29. Thanks for running all the numbers for us … I went with a 30 yr for myself, and have been trying to pay as if a 15 yr ever since I read Automatic Millionaire … now I know I did the right thing!

  30. Another thing to keep in mind is that the $15k you are talking about will come at the end (it’s the last 6 months 15 years from now). Since $15k won’t be worth nearly as much down the road, this will actually turn out to be (effectively) less money than you’re talking about in today’s terms.

  31. Another option you have would be to make an extra payment a year (1/12th a month) and invest the rest of the difference between the 15 year and 30 year mortgage in a low cost mutual fund (Vanguart Total Market Fund, for example). Reinvest the Capital Gains in the Fund and use the dividends each year to make a principal payment. Each year you do this, the amount of the dividend will increase and thus more principal will be paid.

    At 15 years your mutual fund should be worth around $200,000 and at that time you could decide to continue on this path or liquidate the investment to pay off the house (at the very least, the majority of the house)

  32. Jonathan -

    You must be wrong in the calcuation. If you pay the same thing, how come 30 year + prepayment comes ahead of 15-year mortgage?

  33. Jonathan,

    Check out my calculator before you decide. According to my conservative numbers, if you chose the 30-year mortgage over the 15-year and invested the $689 monthly difference at 8%, at the end of 15 years, you’re net worth would be $493,052 (with the 30-year) and $467,390 (with the 15-year).

    The amount you spend on interest is just part of the picture. You also have to consider the opportunity cost of what you are doing.

    Anyway, my calculator isn’t anything fancy but it might help you decide:

    Mortgage Comparison Calculator

  34. We started off with a 30 year fixed fresh out of college but moved to a 15 year fixed (5.25) a couple of years ago. Basically right now we are making two payments a month in order to retire the debt early. It’s the only debt we have and we are focused on getting rid of it! Chris we share some mutual feelings about debt.

  35. I didn’t run the numbers myself, but logically speaking, it seems impossible that you could pay off a 30 year loan in less than 15 years by making the payments as tho it was a 15 year loan since 30 year loans always have higher rates than a 15. Not nitpicking, but something seems wrong w/ that scenario.

  36. Well, you guys are all talking about the “ideal” situation. That is, 1- you will stay in the house till it’s paid off, 2- you have the discipline to actually do the extra payment every month, and 3- you have the extra income to do the extra payment.

    Unfortunately, if you look carefully, most people can’t meet any of these 3 conditions.

    1- Stay in one house forever – majority of the people will sell their homes every 3-5 years according to NAR’s statistics. you will be surprised that many unexpected and yet common conditions will force you to move (child, job, opportunities, etc.) rather quickly. So, instead of planning on living there forever, I think you should plan on both short term and long term residency. Of course there are two school of arguments on whether you should even consider to stay in one place for long term. Moderate flipping (sell every 2-5 years) is apparently the strategy for a lot of homeowners in the last decade or so. They made a lot of money by doing it and their investment returns were generally higher than stock. However, I see this investment strategy is failing now since the real estate bubble is going to burst anytime now.

    2- Got the discipline ? forget it. Some 40% of people can?t even stay married for 15 years. You will always find excuses to spend or invest your 38% extra cash somewhere else. I don?t believe in a heart beat that someone can actually do this all the way through the 15.5 year period. You might, however, able to pay a large chunk of principle off at a specific moment. For example, one of my co-workers got a big bonus and an inheritance and he decided to put them all in his equity. But, again, you can still pre-pay your 15 year mortgage with extra cash and own your house in 7 years if you want to. Thus, extra payment occasionally and paying extra consistently are is quite different in nature.

    3- Got the extra cash ? yeah, right! I believe that most people opt for 30-year-fixed or ARM not because they want the ?flexibility?, but because they are maxing out their monthly payment level in order to buy the largest and nicest houses possible. That?s why you see people making $40k/year buying homes in $300k range, people making $60k/year buying homes in $500k range, and people making $100k/year buying million dollar homes. In actuality, none of these people are buying homes in their affordability range. People who are making $100k a year really should buy a house that?s in $300-$400k range, in my opinion. On top of that, there are a lot of home expenses that first time home buyers aren?t aware of. New appliances, new deck, some nice remodeling (tile, floor), furniture, and then there are those unexpected repairs (there are thousands things that can go wrong in a house.)

    So, what?s the answer to your question? It depends on your affordability. Calculate a monthly payment amount that you think is reasonable, put that in mortgage calculator to find out the price of house you can afford. I bet, you will almost certain that you would want to go for the higher priced house based on the 30-year-fixed mortgage loan simply because it?s nicer and bigger. Whether you are willing to settle in a cheaper, smaller house in order to pay the same amount each month but pay it off faster, that?s the real question here.

    By the way, bigger and nicer is not always ?bad?. Nicer homes in nice neighborhood will hold their value better and probably appreciate faster. So, to protect your investment, you may want to max out your monthly amount in order to get the best possible investment potentials.

  37. I just used the calculators on multiple sites of which the underlying formulas I don’t know, but they all agree. You guys are welcome to run them yourselves. My guess is that it has to do with the amortization schedules. Somehow you are paying off the principal even faster than the 15-year amortization schedule, so in the end you had to pay less interest?

  38. the-insider says:

    Jonathan,
    Not sure if you used published rates for your recalculations (6 for 15, 6.5 for 30), but the spread seems way too high – Just wanted to caution you of relying on math that may lull you into thinking that the 30 year is a better option. Another option is to take the 30-yr mortgage and make only one extra payment towards principal every year – that’ll knock off about 7 years. This will give you the flexibility of a smaller payment and avoiding the discipline required to make more in extra payments

  39. I looked at Pentagon Federal Credit Union (PenFed.org), at they have 15-Year Fixed at 5.875% and 30-Year at 6.625%, so that’s a spread of 0.75%. I’ve seen anywhere from 0.25 to 0.75.

    I also ran it with a small spread of 6.75%/7.0%, and in that case it would still be shortened to 14.6 years. Looking closer, the Dinkytown calculator lists the amortization schedule and balance every month, and it shows that the remaining principal balance after each year is actually lower with the 30-year + prepay than with the 15-year.

  40. Jonathan.

    GL with your house buying. But I think you should also consider the price of the house you are buying. I’m not sure if you’ve read articles at http://thehousingbubbleblog.com/ – but the comments and the numbers (for CA, AZ and NJ) seem pretty scary.

    I think it’s good that you’re doing calculations, that might shave extra 5-8 months off even 15 year schedule. But you should also consider the cost of house too. I mean (as per suggestions from the link above) select 3 houses and make lowball offers on them (say 30% less than the asking price). One who took a interst only loan and is finding it difficult to maintain payment schedule will probably accept your offer. I think using this technique, you might even end up paying up the balance in 10 years.

    BTW there is a lot of talk in news, magazines, blogs on the housing bubble. I think it would be interesting if you start a post on it and strategy for extracting the maximum concession from a motivated seller.

  41. Jonathan,

    Your conclusion of the result (using 30 year’s amortization but prepaying the difference of 30 year vs 15 year mortgage) is going to make the term to be shorter than 15 years is incorrect.

    I also used the calculator at Dinkytown.net and the result really shows that you will shorten the payment period of 30 years by roughtly 14.25 year and thus you actually need 15.75 years to pay off the loan.

  42. Hmm… you’re right. I just re-did the numbers and I get 15.5-16 years. I think I switched the rates?

  43. My question is what kind of house will you be buying for a $300,000? I hope you are not in CA, as for $300K you would not be able to afford a condo. Also don?t forget to budget for property taxes, HOA fees (if you do buy a condo), the usual homeowners insurance, but then there is earthquake/flood depending on where you are and so on? All of these things add up! Also if you have 20% down that is great (the interest rate will be lower), but if you don?t you will be paying PMI. As a homeowner, I would suggest having at least 10% down then you can get an 80% – 10% loan. If you are getting close to buying a house, try getting pre-approved on a loan a head of time, so you can see the actual interest rate that you will be getting. The interest rate of around 6% for 30-year fixed loan sounds too good to be true… Good Luck!

  44. “BTW there is a lot of talk in news, magazines, blogs on the housing bubble. I think it would be interesting if you start a post on it and strategy for extracting the maximum concession from a motivated seller. ”

    One reason to stock-pile some cash rather than pay-down your mortgage with every last cent is to prevent yourself from becoming one of those “motivated sellers”. Being able to weather a 1 depreciation cycle without having to undersell your house could be worth more than paying your house off early.

  45. I just recently bought my first home, close in a couple of weeks actually, I went with Etrade and bought some point sin advance, ended up with my loan at 5.875%. You should also looking into that… it might complicate your calculators some ;) paying some in advance.. but if you’re going to be in the home for 5+ years it’s usually a good deal.

  46. Jonathan:

    I would base the decision of whether to go with 30 yr vs 15 yr purely based on affordability. Based on your monthly income, see how much you can reasonably pay towards your monthly mortgage, taking into account other factors (e.g., property taxes, extra maintenance/utility costs, saving on current rent payment, insurance etc.). If that amount can cover a 15 yr mortgage payment, go with 15 yr. If not go with 20 or 30 yr mortgage. In other words, the least APR term for which you can afford monthly payments without any hardship.

    If you run into extra savings (e.g, annual bonus, future raises etc., essentially the unanticipated extra future income) you can consider whether to make additional principal only payments to payoff the mortgage quicker or use it for other purposes depending on your situation then. But I would not go for a longer term mortgage, just so that I have the flexibility to make prepayments, as long as I can reasonably afford the shorter term mortgage payments.

    One other things I want to add:
    There is simply no way that you can come out ahead with 30 yr + prepay as compared with a 15 yr mortgage as long as two simple assumptions are true: you borrow the same amount in both cases, the interest rate on 30 yr is more than that on 15 yr, and you make the same total monthly payment in either case. It is just mathematically impossible.

    GoodLuck!

  47. As far as flexibility were you to run into tough times — instead of opting for the 30 and you pay it off faster when you can, why not opt for the 15-year and have an emergency fund for this “flexibility” that has been mentioned in many comments? Best of both worlds in my opinion. Built in flexibility (EF) and forced discipline.

  48. Get a 30 year fixed interest only! A mortgage broker should be able to get you this type of loan from Wells Fargo.

    The first 15 years are interest only payments with no prepayment penalty.

    The last 15 years are principle + interest at a 15 year loan amortization.

    All 30 years are at the fixed rate. Pay points (wrap them into the loan) and get the rate as low as it can go.

    The above assumes that you plan to keep the house for a relatively long time – over 5 years.

    The risks – if rates go down you may have wasted some money, the rewards if rates go up you are locked in for 30 years at a great rate. Having the flexibility to have the lowest payments possible is nice and is why I personally would always choose a 30 year over a 15 year – unless you are very wealthy you want to keep your money in your pocket and not in the banks.

    If your time horizon is shorter then looking at 3-5 year interest-only ARMs is probably the way to go.

    Bottom Line: Never ever prepay your mortgage – if you can afford to put more money in, invest it instead – money that you give the bank is dead money and will lose value to inflation over time, whereas if it is invested it will beat infation. The only exception to this idea is if your time horizon is very short – (5 years or less) then it makes sense to pre-pay if you can’t beat your mortgage interest rate with safe investements (CDs, Money Makets, etc). Over 5 years a diversified portfolio should beat your mortgage rate.

  49. How about the return that you can earn on the money you’ve borrowed?

    if you go w/ 30-yr mortgage and put difference monthly payment in S&P Index funds (or ETFs) and let that money grow, it will be much more than your investment in house after 15 years even after assuming 9% annualized return over 15 years.

    So why take 15 year mortgage in that case???

  50. I prefer 15 years than 30 years. The rate is better, a lot of times there’s problems when you try to pay more as they don’t like to apply it towards the principle and sometimes it can be a hassle.
    Also data shows that around 95% of those who say they will get a 30 year mortgage and pay it off in 15 years never end up doing. A 15 year mortgage isn’t bad and that much more money, but of course it depends on your loan amount and your rate.
    I’ve always heard from those I respect that if you can’t afford a 15 year mortgage, you can’t afford the house.

  51. Kerry,

    You suggested sending in the exta principal payment before the actual mortgage payment is due. If I read you correctly, this reduces the principal for the upcoming mortgage payment. I am struggling to understand how this is different than an extra principal payment with the actual mortgage payment (except that the extra payment is shifted forward by one cycle). Does the scenario you describe save some money in the long run that is material?

  52. Well, at least suzy orman thinks that the home should ideally be prepaid, by making extra payments. See this link:

    http://finance.yahoo.com/columnist/article/moneymatters/8931

  53. When I was doing my shopping last August for a 30year and 15 year, I was being quoted 5.5% for 30 year and 4.875% for 15 year fixed. The spread that was available to me was quite different than the one you are using.

  54. A 30 year mortgage loan is better for me. You get lower monthly payments and you can invest the rest. The interest rates are still very low and I can get a higher return on my money. You may have to pay more in interest in the long run but it is tax deductable. Also it gives you more freedom to pay off other debts since you will not be strapped for cash.

  55. That’s because Suzy Orman is a paid speaker and author, not a financial guru… Her advice on this subject is poor – it wont get people into trouble, but it also won’t get them to retirement any faster. her logic in that article makes no sense “it feels more secure” – I feel like using my money in a smart logical well analyzed way not in a way that emotionally feels good!

    Look at it this way, you wouldn’t put your 401(k) savings into all bonds because over the long term you would do horibble – a 30 year loan is a long-term thing, why pay it down when you can invest the money and have it work for you? The other main point is that once the bank has your money its gone – if you hit hard times you lose the house (you can’t qualify for a loan without income), if you have it invested you can get access to it very easily and continue to pay your mortgage while you find a new job.

    Maximizing returns and managing risk are what make me “feel secure”.

  56. I’m with you. We have a 30 year fixed and pay extra for just those reasons!

  57. methodmuse says:

    I have been doing exactly what Juston and some others are saying. My mort is 30 yr @ 5.375% and of course is tax deductable. It’s just never made sense to me to pay extra on that. I invest any extra cash I have in my brokerage acct which is now pretty substantial… I’d much rather have that money working for me as it is than to have it in home equity. And it’s there if I need it.

    This is also how I look at my student loan. It’s only about 10K and I could pay it off easily but I have an obnoxiously low rate on it to the point where it makes zero sense to pay that off any faster than I have to when I can invest any extra money I might have.

  58. bigworm000 says:

    IMO theres not that much difference in 1700 and 2400. I would go for a 15 year loan but make sure that the mortgage is something that you can afford. If some hardship comes up and you have to scrimp 700 bucks off of a would be house payment to adapt it seems to me you really cant afford the house payment in the first place. If some hardship comes up you should have enough income coming in to be saving some each month for jsut this type of situation and still be able to pay your normal house payment. imo 15000 dollars is alot of money to waste for the “security” of being able to make a slightly less but still huge 1700 house payment :P

  59. alegna1010 says:

    Please look into Bi-Monthly Calculator at http://www.alliemae.org/bi-monthlycalculator.html
    Save even more money whether 15, 20, or 30

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